The immediate fears surrounding Chesapeake Energy (NYSE:CHK) appear to have passed. A falling stock market and plunging oil prices late last year led to a selling spree in CHK stock. However, as oil prices have moved back above the $50 per barrel mark, interest in CHK returned.
Still, for all of these improvements, Chesapeake Energy stock remains a struggling penny stock. As such, a sustained drop in oil prices could compromise the profits on which CHK has slowly built a recovery. Still, assuming it can stay the course and continue to reduce its debt, CHK stock appears positioned for an eventual move higher.
CHK Stock Is Back. . . To Its Slow Recovery
CHK stock has enjoyed a dramatic recovery since Christmas Eve. From its 52-week low of $1.71, it has surged to around $2.90 per share range in under a month.
A few factors have worked in favor of CHK stock in that time. For one, the overall market recovered. The S&P 500 has increased by over 11% since the December 24th low. Oil prices, which saw a surprisingly dramatic plunge in the last months of 2018, have begun to recover. As a result, West Texas Intermediate (WTI) crude again trades at over $50 per barrel.
Both Risk and Reward Lies in the Balance Sheet
While concerns of an impending bankruptcy have abated, this takes us back to the scenario described in my previous article on CHK stock.
Chesapeake remains a $2.55 billion company with negligible cash reserves. It also still holds almost $9.4 billion in long-term debt. This may explain why CHK remains a penny stock despite a 4.5 forward P/E ratio. Given these circumstances, CHK stock remains a poor choice for risk-averse investors.
However, for those who can tolerate more risk and want a speculative play, I see a high degree of potential for Chesapeake. For one, despite the high costs of servicing its debt, analysts forecast profits every year through at least fiscal 2020.
As it realizes those profits, Chesapeake can pay down more of its debt. Reduced debt should lead to a higher CHK stock price over time. This virtuous cycle of falling debt and higher equity would return Chesapeake to financial stability in time.
Strategic Moves Should Pay Off, Eventually
I think the strategic moves that might have concerned investors will ultimately build confidence in CHK. CEO Doug Lawler announced that the company would reduce active rig counts from 18 to 14 for 2019.
Some might wonder how reducing the number of rigs improves the business. My colleague James Brumley believes it helps. He described this move as prioritizing “quality over quantity,” and I agree. With oil prices down by almost one-third from their October highs, I think this makes sense. The production level of 462,000 to 464,000 barrels of oil equivalent per day fell from last year’s numbers. However, it comes in ahead of the 448,000 per day analysts had expected.
Also, the costs of the proposed $4 billion acquisition of Wildhorse Resources (NYSE:WRD) probably made some investors nervous as well. However, it increases the company’s stake in oil, which for now produces much higher margins than natural gas.
Speaking of natural gas, its margins should also improve over time. CHK remains one of the largest natural gas producers in the country. As such, it can benefit from the burgeoning export industry in liquefied natural gas (LNG).
A third terminal began LNG production in Corpus Christi, Texas late last year. Several other terminals are in the planning stages, and analysts estimate that the U.S.’s export capacity will more than double this year. Both Cheniere Energy (NYSEAMERICAN:LNG) and Dominion Energy (NYSE:D) operate terminals. In the coming months, industry analysts expect Kinder Morgan (NYSE:KMI) and Freeport LNG to finish construction on their terminals.
The Bottom Line on CHK Stock
For all of the price fluctuations and possible strategies that can affect CHK stock, maintaining a virtuous cycle of falling debt and rising stock prices remains critical to inspiring confidence.
The immediate fears caused by the drop in oil prices appear to have passed. Oil again trades over $50 per barrel. Also, production should become more focused once the Wildhorse Deal closes in February. Moreover, prospects for natural gas should only improve as more LNG export terminals come online.
Still, for all of the optimism, debt levels remain well above the market cap. But profit forecasts for CHK stock offer a plausible path back to financial stability. If debt continues falling, those investors who bear the high risks of CHK should enjoy massive gains as Chesapeake stabilizes. However, no matter how much oil and natural gas prices influence moves in the stock, it is debt and equity that will ultimately define CHK stock.
As of this writing, Will Healy is long CHK stock. You can follow Will on Twitter at @HealyWriting.